Dividend Policy, Personal Taxes and Optimal Capital Structure

This paper puts forward a capital structure model that incorporates the impacts of dividend policy and personal taxes that are commonly ignored by the existing capital structure models. The results show that paying dividends can reduce the tax benefits from issuing debts, which explains why existing capital structure models commonly overestimate leverage ratios. The results further show that as dividend payout increases, leverage ratios and credit spreads increase too. By incorporating the impacts of dividend policy and personal taxes, the capital structure model established in this paper can generate wide range of leverage ratios and credit spreads, which are consistent with what are observed in the real world.